IFRS Construction Contracts and Interests in Joint Ventures

Transcription

1 IFRS Construction contracts and Interests in joint ventures IFRS Construction Contracts and Interests in Joint Ventures Farah De Rouck Véronique Weets Instituut der Bedrijfsrevisoren September 15, 2008

2 IFRS Construction contracts and Interests in joint ventures FACILITATORS VÉRONIQUE WEETS Dr. Véronique Weets is a Professor of International Accounting and a faculty member at two Belgian universities. In that role she is responsible a general IFRS course and a Financial Instruments course. At regular occasions she participates in Master Programs of UAMS, Programs of Vlerick and the Solvay Business School. Véronique Weets was also associated with the IFRS Technical desk of Deloitte in Belgium, where she was involved in client work on matters such as the transition to IFRS and the subsequent application of IFRS to listed companies. She was also responsible for client trainings as well as trainings of the professional staff. As from 2006 Véronique Weets created her own company in which she helps clients with the application of IFRS on a daily basis through trainings or consultancy. This means that she actively searches for the practical translation of this principle based framework of accounting in order to provide realistic solutions to the clients. Therefore, facilitation sessions provided by Véronique Weets always have a strong theoretical basis that is translated to practical applications that are relevant to the business environments of the delegates. In addition to this, Véronique Weets is also an author of a long list of technical accounting literature in English, French and Dutch. FARAH DE ROUCK Farah De Rouck is currently working with GDF SUEZ Energy International, where she advises on IFRS implications for a wide range of transactions. GDF SUEZ is a major international utility Group which develops and manages gas and electricity projects around the world. Before joining GDF SUEZ, Farah worked in the Technical Department of Deloitte in Belgium, where she managed IFRS and US GAAP implementation projects for several entities. Her experience with US GAAP technical issues comes through her work as a public accountant with KPMG LLP in the United States and also her involvement with 'Big Four' US GAAP and SEC engagements in Europe. She is a Belgian Bedrijfsrevisor, a US Certified Public Accountant, and a regular instructor at seminars and courses. DISCLAIMER Whilst every effort is made to ensure that the contents of its case studies and other material handed out during or in connection with courses are accurate and up to date, we shall not be under any liability whatsoever for any inaccuracy or misleading information whether arising for negligence or otherwise and in particular we shall not be liable for any consequential damage or expense of any loss of profit or any liability to third parties incurred as a result of reliance on such inaccurate or misleading information. REFERENCES (OTHER THAN THE OFFICIAL PUBLICATIONS OF THE IASB) Deloitte, igaap 2005 IFRS Reporting in the UK, CCH PWC, Manual of Accounting IFRS for the UK 2007, CCH Melville Alan, International financial reporting A practical guide, 2008, FT Prentice Hall Instituut der Bedrijfsrevisoren September 15, 2008

3 IFRS Construction contracts and Interests in joint ventures OVERVIEW Introduction Construction contracts o Objectives and scope o Definitions o Recognition of revenue o Recognition in the statement of financial position o Disclosures o Special topics Combining and segmenting construction contracts IFRIC 12 Service concession arrangements IFRIC 15 Agreements for the construction of real estate Amendment of IAS 23 Borrowing costs Interests in Joint Ventures o How to account for an entity s investment in its consolidated financial statements? o Accounting impacts o Joint ventures under current IAS31 o Joint arrangements under ED9, changes expected o Special topics Instituut der Bedrijfsrevisoren September 15, 2008

4 IAS 11 Construction contracts IAS 31 - Financial reporting of interests in joint ventures Farah De Rouck Véronique Weets

5 IAS 11 Construction contracts Overview Objectives and scope Definitions Recognition of revenue Recognition in the statement of financial position Disclosures Special topics Combining and segmenting construction contracts IFRIC 12 Service concession arrangements IFRIC 15 Agreements for the construction of real estate Amendment of IAS 23 Borrowing costs

6 Objectives and scope Construction contract Contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use. Contracts where activity usually falls within two or more accounting periods Criteria for contractors to allocate revenue and cost

7 Definitions Fixed price contract Agreed fixed contract price, or a fixed rate per unit of output (plus ecalation clauses) Cost plus contracts Reimbursement for defined costs, plus a percentage of these costs or a fixed fee Combination E.g. cost plus contract with maximum price

8 Definitions Contract revenues Revenue = Agreed contract price +/- Variations +/- Claims +/- Incentives Fair value of the consideration (estimates) To the extent revenue is probable; and Reliable measurement is possible

9 Definitions Contract costs Include Direct costs Labor and materials PPE depreciation Moving and hiring plant Design Rectification and warranty Claims Indirect costs Insurance Construction overheads Borrowing costs Costs specifically chargeable Reimbursed design General administration Exclude General administration (unless reimbursed) Selling costs Research and development (unless reimbursed) Depreciation of idle plant Cost cut-off From the date of securing contract To completion of contract Pre-contract costs?

10 Recognition of revenue Framework An item that meets the definition of revenue should be recognised if: It is probable that any future economic benefit associated with the item will flow to or from the entity; and the item has a cost or value that can be measured with reliability. IAS 11 When the outcome of a construction contract can be estimated reliably contract revenue and contract costs shall be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the end of the reporting period An expected loss shall be recognised as an expense immediately

11 Recognition of revenue Percentage of completion Use method that measures reliably the work performed Proportion that contract costs incurred for work performed to date bear to the estimated total contract costs Surveys of work performed; or Completion of a physical proportion of the contract work. Progress payments and advances received from customers often do not reflect the work performed.

12 Recognition of revenue The outcome can be estimated reliably For a fixed price contract, if Total contract revenue can be measured reliably; It is probable that the economic benefits associated with the contract will flow to the entity; Both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably; and The contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates

13 Recognition of revenue The outcome can be estimated reliably For a cost plus contract, if It is probable that the economic benefits associated with the contract will flow to the entity; The contract costs attributable, whether or not specifically reimbursable, can be clearly identified and measured reliably.

14 Recognition of revenue When the outcome of a construction contract cannot be estimated reliably Revenue shall be recognised only to the extent of contract costs incurred that are probably recoverable; and Contract costs shall be recognised as an expense in the period in which they are incurred. When uncertainties about outcome no longer exist Apply percentage of completion

15 Recognition of revenue When it is probable that total contract costs will exceed total contract revenue, the expected loss shall be recognised as an expense immediatly, irrespective of Whether work has commenced on the contract; The stage of completion of contract activity; or The amount of profits expected to arise on other contracts which are not treated as a single construction contract.

16 Recognition in the SOFP An entity shall present The gross amount due from customers for contract work as an asset; The gross amount due to customers for contract work as a liability Amount due from/due to customers is Costs incurred plus recognised profits, less The sum of recognised losses and progress billings

17 Disclosures General disclosures Contract revenue in the period Methods to determine revenue recognised Methods to determine stage of completion For each open contract Aggregate costs and recognised profits (less recognised loses) to date Amount of advances received Amount of retentions

18 Special topics

19 Overview Combining and segmenting construction contracts IFRIC 12 Service concession arrangements IFRIC 15 Agreements for the construction of real estatem Amendment IAS 23 Borrowing costs

20 Combining and segmenting construction contracts

21 Combining and segmenting construction contracts Combining Contracts negotiated as single package Closely interrelated effectively a single project with an overall profit margin Performed concurrently or in a continuous sequence Segmenting Separate proposals submitted for each asset Assets separately negotiated, individual acceptance or rejection is possible Cost and revenues can be identified separately

22 19 IFRIC 12 Service Concession Arrangements

23 Overview Introduction Definitions Common features of Service Concession Arrangements Scope of IFRIC 12 Accounting for a SCA by the operator 20

24 Introduction IFRIC 12 was issued 30/11/2006 and: Applies to accounting by operators of private to public service concession arrangements Entities shall apply the interpretation for annual periods beginning on or after 1/1/2008 No transitional provisions 21

25 Definitions Service Concession Arrangements are arrangements: in which the public sector attracts private sector participation in the development, financing, operation and maintenance of infrastructure for public services. 22

26 Definitions GRANTOR Public Service Concession Arrangement sets out: Performance standards Mechanisms for adjusting prices Arrangements for arbitrating disputes OPERATOR Private Operator activities: Construct/upgrade infrastructure Operate and maintain infrastructure for a specified period of time 23

27 Common features of a SCA Contract Obliges the operator to provide the services to the public on behalf of the grantor Sets the initial prices to be levied by the operator and regulates price revisions over the period of the service arrangement The grantor is a public sector entity or a private sector entity to which the responsibility for the service has been delegated The operator is responsible for management of the infrastructure and related services and does not merely act as an agent on behalf of the grantor is obliged to hand over the infrastructure to the grantor in a specified condition at the end of the period of the arrangement, for little or no incremental consideration. 24

28 Scope of IFRIC 12 Public to Private Service Concession Arrangements in which: The grantor controls services provided by the operator; and Either The grantor controls any significant residual interest in the infrastructure at the end of the concession arrangement; or No significant residual interest exists 25

29 Accounting for SCA by the operator The operator does not recognize the assets as PPE or leased assets Financial Assets if Grantor agrees to pay a specified amount; or Grantor agrees to guarantee the shortfall between amounts received from users and a specified amount Intangible Assets if Grantor only pays when users use the service Grantor only grants a right to charge users for the service Bifurcated Assets If the consideration is partly by a financial asset and partly by an intangible asset 26

30 27 IFRIC15 Agreements for the construction of real estate

31 Scope and issue Scope Accounting for revenue and associated expenses by entities that undertake the construction of real estate directly or through subcontractors Agreements for the construction of real estate Issues Is the agreement within the scope of IAS 11 or IAS 18? When should revenue from the construction of real estate be recognised? 28

32 Definition A construction contract is a contract specifically negotiated for the construction of an asset (IAS 11.3). When the buyer is able to specify the major structural elements of the design of the real estate before construction is in progress. 29

33 Consensus When the agreement is within the scope of IAS 11 and its outcome can be estimated reliably Recognise revenue by reference to the stage of completion When the agreement is not within the scope of IAS 11 Agreement for rendering of services: Recognise revenue by reference to the stage of completion Agreement for sale of goods (construction materials): If all criteria of IAS are met continuously as construction progresses: percentage of completion Otherwise: wait until criteria are met 30

34 Transition and effective date Annual periods beginning on or after 1/1/2009 Changes in accounting policy shall be accounted for retrospectively in accordance with IAS 8 31

35 32 IAS 23 Amendment Borrowing Costs

36 Core principle Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset; Other borrowing costs are recognized as an expense. Exemptions A qualifying asset measured at fair value; Inventories that are manufactured, or otherwise produced, in large quantities on a repetitive basis. Not: Financial assets Assets that are ready for their intended use 33

37 Effect study report of the EC A majority of respondents prefer the capitalisation method and/or support the endorsement of the standard. Even among capital intensive companies that would be affected most by the revised IAS 23 Benefits of the capitalisation model include: Increased comparability because one of the current options is eliminated Including borrowing costs in the cost of the assets is a better conceptual approach than expensing Costs of adopting IAS 23 Revised: Relatively small percentage of companies because most do not have any qualifying assets. Main part of these costs will be related to the first implementation of the revised standard and therefore not recurring. 34

38 Questions?????

39 IAS 31 - Financial reporting of interests in joint ventures - Overview How to account for an entity s investments in its consolidated financial statements?? An overview Accounting impacts Joint ventures under the current IAS31 Joint arrangements under ED9, changes expected Special topics

40 ACCOUNTING FOR INVESTMENTS

41 OVERVIEW How to assess appropriate method of accounting in consolidated financial statements? Power to govern Control Joint control Significant influence Less than significant influence 38

42 INTRODUCTION How to assess appropriate method of accounting in consolidated financial statements?? Control approach Risk and reward approach In a nutshell Control approach: the party that has the power to govern the financial and operating policies consolidates Risk and reward approach: the party that bears the majority of risks and rewards consolidates 39

43 DIFFICULTY The control, and the risk and reward approach may produce conflicting outcomes, and Under current IFRS, very limited guidance exists, as When to apply the risk and reward approach, and How to apply the risk and reward approach. Question: are businesses autopilot companies inside the scope of SIC12?? 40

44 CONTROL Power to govern Investment Significant influence Joint control Control Fair value or cost FINANCIAL INSTRUMENT Equity method of accounting ASSOCIATE Proportionate Consolidation Or Equity method of accounting JOINT VENTURE Full consolidation SUBSIDIARY 41

45 CONTROL Definition: the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Substance over form! Potential voting rights with economic substance (e.g. call options); Actions from government; Etc. 42

46 CONTROL Approach: What bodies govern the entity (shareholders, directors, CO s, etc.)? What are their relative powers? What is the investor s degree of influence/control on those? 43

47 REBUTTABLE PRESUMPTION CONTROL Direct or indirect ownership of more than half of the voting power; Power over more than half of the voting rights by virtue of an agreement with other investors; Power to govern the financial and operating policies of the entity under a statute or an agreement; Power to appoint or remove the majority of the members of the board of directors or equivalent governing body and control of the entity is by that board or body; or Power to cast the majority of votes at meetings of the board of directors or equivalent governing body and control of the entity is by that board or body. 44

48 JOINT CONTROL Joint control is the contractually agreed sharing of control over an economic activity, and exists only when the strategic financial and operating decisions require unanimous consent of the venturers A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control Two characteristics: Two or more venturers are bound by a contractual arrangement (e.g. Shareholders Agreement), and The contractual arrangement establishes joint control. 45

49 JOINT CONTROL One venturer may be the operator or manager of the joint venture. As long as he acts within the financial and operating policies agreed by the venturers, he does not control the economic activity. If one party to the contractual arrangement should be in a position to unilaterally govern the financial and operating policies he has control instead of joint control. Hereto the extent of the decisions requiring sharing of control should be analyzed. Judgment is required. DE FACTO CONTROL OVERRULES CO- CONTROL!!! 46

50 Interpretation based on USGAAP EITF Protective rights: protect a shareholder s interest and would not overcome the presumption of co-governance of strategic financial and operating policies. Substantive participating rights: allow effective participation in corporate actions and would confirm presumption of co-governance of strategic financial and operating policies. 47

51 SIGNIFICANT INFLUENCE Definition: the power to participate in the financial and operating policy decisions of the investee but is not control over these policies. Rebuttable presumption of significant influence: direct or indirect ownership of 20% or more of the voting power of the investee A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. 48

52 SIGNIFICANT INFLUENCE Usual indicators: Representation on the board of directors or equivalent governing body; Participation in the policy-making processes, including participation in decisions about dividends or other distributions; Material transactions between the investor and the investee; Interchange of managerial personnel; or Provision of essential technical information. 49

53 IFRS UPDATE Consolidation: Clarify/reconcile control and risk/reward approach Expected dates Exposure draft: Q IFRS: H

54 Accounting impacts

55 Equity method Under the equity method, the investment is initially recognized at cost and the carrying amount is increased or decreased to Recognize the investor s share of the profit or loss of the investee after the date of acquisition and Changes in the investee s equity that have not been recognized in the investee s profit or loss. 52

56 Equity method The investor s share of the profit or loss of the investee is recognized in the investor s profit or loss. The investor s share in the other changes in equity of the investee are recognized in equity. Distributions received from an investee reduce the carrying amount of the investment. 53

57 Equity method An investor shall discontinue the use of the equity method from the date that it ceases to have significant influence. The carrying amount of the investment at the date that it ceases to be an associate shall be regarded as its cost on initial measurement as a financial asset in accordance with IAS

58 Equity method Profits and losses from upstream and downstream transactions are recognized in the investor s financial statements only to the extent of unrelated investors interests in the associate. On acquisition Goodwill is included in the investment; Negative goodwill is included as income in the determination of the investor s share of the associate s profit or loss of the period 55

59 Equity method Requires Same reporting date Uniform accounting principles If an associate/joint venture has outstanding cumulative preference shares that are held by parties other than the investor and classified as equity, the parent computes its share of profits or losses after adjusting for the dividends on such shares, whether or not dividends have been declared. 56

60 Equity method If an investor s share of losses of an associate equals or exceeds its interest in the associate, the investor discontinues recognizing its share of further losses. Interest in the associate: CA of the investment in the associate under the equity method together with any long-term interests that, in substance form part of the investor s net investment in the associate. 57

61 Equity method After the investor s interest is reduced to zero, additional losses are provided for, and a liability is recognized, to the extent that the investor has incurred legal or constructive obligations or made payments on behalf of the associate. If the associate subsequently reports profits, the investor resumes recognizing its share of those profits only after its share of the profits equals the share of losses not recognized. 58

62 Proportionate consolidation Balance sheet of the investor includes its share of the assets in the investee and its share of the liabilities. The income statement includes its share of the income and expenses of the investee. Two formats: Combine share of each of the assets, liabilities, income and expenses with the similar items, line by line, in the financial statements Include separate line items for its share of the assets, liabilities, income and expenses of the investee 59

63 Proportionate consolidation No off-setting unless a legal right of set-off exists and the offsetting represents the expectation as to the realization of the asset or the settlement of the liability. 60

64 CASE Equity method of accounting and proportionate consolidation 61

65 IAS 31 Interests in Joint Ventures

66 Overview Key definitions Forms of joint venture Accounting for joint ventures Transactions between a venturer and a joint venture Disclosures 63

67 Key definitions Joint Control: contractually agreed sharing of control over an economic activity, and exists only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the parties sharing control (the venturers). A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control. The following characteristics are common to all joint ventures: Two or more venturers are bound by a contractual arrangement; and The contractual arrangement establishes joint control 64

68 Key definitions Investor in a joint venture: party to a joint venture that does not have joint control over that joint venture Venturer: party to a joint venture that has joint control over that joint venture 65

69 Key definitions Contractual arrangement Different forms possible: contracts, minutes, discussions, articles or by-laws. Usually in writing and deals with matters as: The activity, duration and reporting obligations of the joint venture; The appointment of the board of directors of equivalent governing body of the joint venture and the voting rights of the venturers; Capital contributions by the venturers; and The sharing by the venturers of the output, income, expenses or results of the joint venture. 66

70 Key definitions Contractual arrangement Ensures that no single venturer is in the position to control the activity unilaterally May identify one venturer as the operator or manager of the joint venture Does not control Acts within financial and operating policies 67

71 Quiz Partner Equity interest % and relative voting power A 40% B 30% C 30% Case % needed to approve strategic op and fin decisions 1 50%?? Power to govern from A s perspective? 2 70% 3 80% 68

72 Forms of joint venture Joint Ventures Jointly controlled entities Jointly controlled operations Jointly controlled assets Must be entity and keep separate records No legal entity formed, no separate records needed Proportionate consolidation Equity method of accounting 69

73 Forms of joint venture Jointly controlled operations: Each venturer uses its own property, plant and equipment and carries its own inventories. It also incurs its own expenses and liabilities and raises its own finance, which represent its own obligations. Joint venture arrangement usually provides a means by which the revenue from the sale of the joint product and any expenses incurred in common are shared among venturers. 70

74 Forms of joint venture Jointly controlled assets: Joint control, and often the joint ownership of one or more assets that are used to obtain benefits for the venturers. Each venturer may take a share of the output from the assets and each bears an agreed share of the expenses incurred 71

75 Forms of joint venture Jointly controlled entity: Joint venture that involves the establishment of a corporation, partnership or other entity in which each venturer has an interest. The entity operates in the same way as other entities except that a contractual arrangement between the venturers establishes joint control over the economic activity of the entity Controls the assets of the joint venture, incurs liabilities and expenses and earns income. May enter into contracts in its own name and raise finance for the purpose of the joint venture activity 72

76 Forms of joint venture Jointly controlled entities: Maintains its own accounting records and prepares and presents financial statements in the same way as other entities in conformity with IFRS 73

77 Jointly controlled operations Venturer shall recognize in its financial statements: The assets that it controls and the liabilities that it incurs; and The expenses that it incurs and its share of the income that it earns from the sale of goods or services by the joint venture 74

78 Jointly controlled assets A venturer shall recognize in its financial statements: Its share of the jointly controlled assets, classified according to the nature of the assets; Any liabilities that it has incurred; Its share of any liabilities incurred jointly with the other venturers in relation to the joint venture; Any income from the sale or use of its share of the output of the joint venture, together with its share of any expenses incurred by the joint venture; and Any expenses that it has incurred in respect of its interest in the joint venture 75

79 Jointly controlled entities Accounted for using proportionate consolidation or the equity method unless: the investment is accounted for in accordance with IFRS 5; or the entity is exempted from producing consolidated financial statements; or same conditions for exemption of application of equity method as for exemption to produce consolidated financial statements 76

80 Accounting for joint ventures An investor in a joint venture that does not have joint control shall account for that investment in accordance with IAS 39 or, if it has significant influence, in accordance with IAS 28. Operators and managers of a joint venture shall account for any fees in accordance with IAS 18 77

81 Intragroup transactions Venturer contributes or sells to joint venture: While the assets are retained by the joint venture, the venturer shall recognize only that portion of the gain or loss that is attributable to the interests of the other venturers The venturer shall recognize the full amount of any loss when the contribution or sale provides evidence of a reduction in the net realizable value of current assets or an impairment loss. 78

82 Intragroup transactions Joint venturer contributes or sells to venturer: The venturer shall not recognize its share of the profits of the joint venture from the transaction until it resells the assets to an independent party The venturer shall recognize its share of the losses resulting from these transactions in the same way as profits except that losses shall be recognized immediately when they represent a reduction in the net realizable value of current assets or an impairment loss. 79

83 CASE Intragroup transactions 80

84 Disclosure Aggregate amount of the following contingent liabilities, unless the probability of loss is remote, separately from the amount of other contingent liabilities: Any contingent liabilities that the venturer has incurred in relation to its interests in joint ventures and its share in each of the contingent liabilities that have been incurred jointly with other venturers; Its share of the contingent liabilities of the joint ventures themselves for which it is contingently liable; and Those contingent liabilities that arise because the venturer is contingently liable for the liabilities of the other venturers of a joint venture 81

85 Disclosure A venturer shall disclose the aggregate amount of the following commitments in respect of its interests in joint ventures separately from other commitments: Any capital commitments of the venturer in relation to its interests in joint ventures and its share in the capital commitments that have been incurred jointly with other venturers; and Its share of the capital commitments of the joint ventures themselves 82

86 Disclosure Listing and description of interests in significant joint ventures and proportion of ownership held in jointly controlled entities If proportionate consolidation line-by line or equity method Aggregate amounts of each of current assets, long-term assets, current liabilities, long-term liabilities, income and expenses related to its interests in joint ventures Method used to recognize interests in jointly controlled entities. 83

87 ED 9 Joint Arrangements

88 Definitions Joint control: the contractually agreed sharing of the power to govern the financial and operating policies of a venture so as to obtain benefits from its activities. Joint arrangement: a contractual arrangement whereby two or more parties undertake an economic activity together and share decisionmaking relating to that activity. 85

89 Definitions Party to a joint arrangement: an entity that participates in shared decisions relating to the joint arrangement. Shared decisions: decisions that require the consent of all of the parties to a joint arrangement. 86

90 Types Joint operations Joint asset Joint ventures At first glance quite similar 87

91 BUT!!! Type depends on the rights and obligations that arise from the contractual arrangement Joint assets and operations: rights to individual assets or contractual obligations for expenses or financing Joint venture: rights to only a share of the outcome generated by a group of assets and liabilities carrying on an economic activity 88

92 AS SUCH The legal form of an arrangement may be indicative, but not conclusive Examples: Shareholders of limited liability company generally do not have a obligation to pay expenses incurred by, and financing of, the company. However a guarantee contract may negate the effect of the limited liability Incorporated business but with unlimited liability Joint venture often involves creation of legal entity (but not necessarily) 89

93 Indicators of rights to individual assets The party has the right to sell its interest in the asset. The party has the right to use the asset for its own purposes for some or all of its useful life. The party has the right to pledge its interest in the asset against its own financing. The party is contractually obliged to pay for its share of the cost of the joint asset, and consequently has contractual rights to that share of the asset. 90

94 A business Usually involves assets and resources working together to achieve an outcome, which requires decisions of a financial and operating nature. A business that is subject to joint control is, therefore, a joint venture, unless circumstances indicate that the parties have contractual rights to the assets of the business and have contractual obligations for the expenses of the business. 91

95 Interest in a joint venture A venturer shall recognize its interest in a joint venture using the equity method, except when: The interest is classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations; or Exemption from preparing consolidated financial statements applies. 92

96 At the date of loss of joint control Joint venture becomes A subsidiary: apply IAS 27 and IFRS 3 An associate: continue to account for interest using the equity method (IAS28) An investment in which the entity has less than significant influence: apply IAS39 93

97 At the date op loss of joint control Unless the joint venture becomes an associate: measure at fair value any interest it retains in the former joint venture. The entity shall recognize in profit or loss any difference between: the fair value of the retained interest and any proceeds from disposing of a part interest in the joint venture; and the carrying amount of the interest at the date joint control is lost. 94

98 Special topics 1'

99 Special topics Business combinations (IFRS 3) Translation of financial statements in foreign currency (IAS 21) Non-monetary contributions by venturers (SIC 13) Potential voting rights Special purpose entities (SIC 12) 96

100 97 IFRS 3 Business Combinations

101 Business Combinations Selected topics (IFRS 3) Definition Cost of acquisition Recognize acquired identifiable assets/liabilities Goodwill Group discussion New IFRS 3R will be effective for annual periods beginning on or after July 1, 2009!!!

102 Definition Business: an integrated set of activities and assets conducted and managed for the purpose of providing Return to investors; or Lower costs or other economic benefits directly and proportionately to policy holders A Business Combination (BC) is the bringing together of separate businesses into one reporting entity. IFRS 3 applies to BC that result in a parent-subsidiary relationship.

103 Cost of Acquisition Sum of the fair values, at the date of exchange, of: Assets given Liabilities incurred or assumed Equity instruments issued by the acquirer Costs directly attributable to the combination Includes fees paid to effect the acquisition (accountants, lawyers, valuation experts) Does not include: general administrative costs, costs of maintaining acquisitions unit, costs of arranging and issuing debt / equity finance

104 Recognition Recognition criteria for acquired identifiable assets & liabilities (even if not on acquiree s books): Assets (other than intangibles): if it is probable that future economic benefits will flow to the acquirer, and its FV can be measured reliably Liabilities (other than a contingent liability): if it is probable that an outflow of resources will be required to settle the obligation, and its FV can be measured reliably, and Intangible asset or a contingent liability if its FV can be measured reliably

105 Recognition Acquirer may obtain identifiable A & L which were not previously recognized by the acquiree Example: tax benefit from tax losses of acquiree recognized as a result of the acquirer earning sufficient taxable income in-process research If A & L are purchased that do not meet recognition criteria there is a direct impact on the amount of goodwill recorded

106 Goodwill Arises as the difference between the cost of the acquisition and the % in the fair value of identifiable assets and liabilities acquired. Positive GW: Cost > % of FV of identifiable net assets Capitalized as an intangible asset Negative GW : Cost < % of FV of identifiable net assets Reassess fair values to confirm bargain purchase Recognize gain immediately in net income

107 Fair Value of Assets / Liabilities Guidelines for fair values include quoted market price arms-length transaction pricing model discounted cash flow

108 Group discussion General: when acquiring a company, what assets and liabilities are most likely to have a fair value that significantly differs from their net carrying amount?

109 106 IAS 21 The Effects of Changes in Foreign Exchange Rates

110 Overview Definitions Translating FC transactions in the functional currency Translating into presentation currency Disclosures 107

111 Definitions Foreign operation - subsidiary, associate, joint venture or branch of a reporting entity, based or conducted in a country or currency other than those of the reporting entity Net investment in a foreign operation - amount of the reporting entity's interest in the net assets of that operation 108

112 Definitions Monetary items - units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency 109

113 Definitions Functional currency - currency of the primary economic environment in which the entity operates The primary economic environment is normally the one in which an entity primarily generates and expends cash Largely depends upon: the currency that influences sales prices the currency that influences costs of providing goods or services Presentation currency - currency in which the financial statements are presented 110

114 Translating into the functional currency Initial recognition Use spot rate at date of transaction (not settlement rate), or Average (e.g. monthly) to approximate for volume transactions May not use contracted or matching rates of forwards Translate first as above, then Look to IAS 39 for guidance on hedging 111

115 Translating into the functional currency Translation at subsequent balance sheet dates Monetary items translated at closing spot rate May not use contracted / forward hedge rates Non-monetary items If measured at historical cost: remain as originally measured (i.e. historic) rate If measured at fair value: translate using rate at date of valuation Recognize differences on translation / settlement as gain or loss as they arise 112

116 Translating into presentation currency Step 1 translate any foreign currency transactions into the functional currency (as above) Step 2 translate the functional currency accounts in the presentational currency 113

117 Translating into presentation currency Assets/liabilities (incl. comparatives) are translated at the closing rate at B/S-date Income and expenses for each I/S (including comparatives) are translated at exchange rates at the dates of the transactions All resulting exchange differences are recognized as a separate component of equity 114

118 Translating into presentation currency Goodwill from the acquisition of a foreign operation and any fair value adjustments on acquisition are treated as assets and liabilities of the foreign operation: Express in the functional currency of the foreign operation; Translate at the closing rate. 115

119 Translating into presentation currency Exchange differences result from: translating income and expense at exchange rates at the dates of the transactions translating assets and liabilities at the closing rate translating the opening net assets at a closing rate that differs from the previous closing rate 116

120 Translating into presentation currency The exchange differences have little effect on the cash flows from operations, so recognize in equity Minority interests are allocated their share of accumulated exchange differences 117

121 Translating into presentation currency Exchange differences arising on a monetary item that forms part of a reporting entity's net investment in a foreign operation are recognized initially as a separate component of equity and recycled to P&L on disposal of the net investment 118

122 Disclosures Amount of exchange differences recognized in income statement Net exchange differences classified in equity, and reconciliation to opening / closing balances Whether presentation currency is different from functional currency, and the reason When there is a change in the functional currency and the reason for that change 119

123 120 SIC 13 - Non-monetary contributions by venturers

124 Issues Contributions to a JCE are transfers of assets by venturers in exchange for an equity interest in the JCE. When should the appropriate portion of gains or losses resulting from such a contribution be recognized by the venturer? How should the additional consideration be accounted for by the venturer? How should any unrealized gain /loss be presented in the consolidated financial statements of the venturer? 121

125 Consensus A venturer shall recognize the portion of a gain or loss attributable to the equity interests of the other venturers except when: Significant risks and rewards of ownership have not been transferred; Gain or loss on the non-monetary contribution cannot be measured reliably; or The contribution lacks commercial substance 122

126 Consensus If, in addition to receiving an equity interest in the JCE, a venturer receives monetary or non-monetary assets, an appropriate portion of gain or loss on the transaction shall be recognized by the venturer in profit or loss. Unrealized gains or losses on non-monetary assets contributed to a JCE shall be eliminated against the underlying assets under the proportionate consolidation method or against the investment under the equity method 123

127 Potential Voting Rights 1'

128 Potential voting rights What: instruments that have the potential, if exercised, to give the entity voting power ( ) over the financial and operating policies of another entity Should be currently exercisable and have economic substance Intention of management and financial ability to exercise are not relevant The proportions of profit or loss and changes in equity allocated to the parent and minority interests are determined on the basis of present ownership interests and do not reflect possible exercise or conversion of potential voting rights. 125

129 126 SIC 12 Consolidation Special Purpose Entities 1'

130 Overview Characteristics of an SPE Consolidation of an SPE Indicators of control of an SPE Conclusion 127

131 Characteristics of an SPE An SPE is an entity: Created to accomplish a narrow and well-defined objective. Often has limits on decisions making powers. Often operated on so called autopilot. The creator may own little or none of the SPE. The creator/sponsor retains significant beneficial interest in SPE (e.g., a debt/equity instrument or participation right). 128

132 Consolidation of an SPE An entity should consolidate the SPE when it controls the SPE. Control The power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. 129

133 Indicators of Control Activities Activities, in substance, are conducted on behalf of the reporting entity, according to its specific business needs. E.g., the activities of the SPE are limited to a single transaction type or limited to certain industries. Frequently, the policy guiding the on-going activities of the SPE cannot be modified, other than perhaps by its creator or sponsor. 130

134 Indicators of Control Decision Making Reporting entity, in substance, has decision-making power to control/obtain control of SPE, or via «autopilot» mechanism has delegated such power. E.g., entity has power to change the SPE s charter of bylaws or power to veto proposed changes to them. 131

135 Indicators of Control Benefits Reporting entity, in substance, has rights to obtain the majority of the benefits of the SPE s activities through an arrangement, device, etc. E.g., entity has rights to majority residual interests in scheduled residual distributions or in a liquidation of the SPE. 132

136 Indicators of Control Risks Reporting entity retains residual or ownership risks and the investors are, in substance, only lenders because their exposure to gains and losses is limited. E.g., capital providers do not have a significant interest in the underlying net assets of the SPE or do not have rights to the future economic benefits of the SPE. 133

137 Conclusion Determining whether or not to consolidate an SPE is a matter of careful judgment; it should be based on all the relevant facts and circumstances. A rebuttable presumption exists that an entity controls an SPE if one or more examples of both the governance and benefits indicators exist. 134

138 Questions?????

139 Disclaimer The instructors take every care in preparing course material to ensure that the content is accurate and up to date. This course material does not provide an exhaustive presentation of treatment of topics presented in accordance with IFRS. As such, when evaluating the underlying accounting treatment, the original IFRS Standards and Interpretations should be consulted, and an advice of a qualified IFRS expert should be obtained when deemed necessary. No responsibility for loss occasioned to any person acting or refraining from acting as a result of such material can be accepted by the instructors.

140 IAS 11 Construction contracts Cases Construction contracts Cases Farah De Rouck Véronique Weets Instituut der Bedrijfsrevisoren 1 15 September 2008

141 IAS 11 Construction contracts Cases TABLE OF CONTENT Table of content...2 Scope of IAS Contract revenue and contract costs...4 Stage of completion...5 Recognition of revenue and cost...6 Contract losses...7 Combining and segmenting construction contracts...8 Recognition in the statement of Financial position...9 IFRIC 12 Service concession arrangements...11 Scope...11 Financial asset/intangible asset...12 Accounting for service concession arrangements...13 IFRIC 15 Agreements for the construction of real estate...16 IAS 23 Borrowing costs...17 Instituut der Bedrijfsrevisoren 2 15 September 2008

142 Construction contracts Scope of IAS 11 SCOPE OF IAS 11 Determine whether IAS 11 should be applied for the following contracts Contract In the scope of IAS 11 Out of the scope of IAS 11 A construction contract with a duration of less than one year A contract to construct large machines that are individually built to customer order and unique specifications A service transaction A software development contract Instituut der Bedrijfsrevisoren 3 15 September 2008

143 Construction contracts Contract revenue and contract costs CONTRACT REVENUE AND CONTRACT COSTS 1. Olegna is nearing the completion of a major contract and is in the process of negotiation with Enile in respect of settlements to be received for variations, claims and incentive payments (Deloitte, i GAAP, pg ). What are the criteria for determining whether such supplementary amounts can be included in contract revenue? 2. Olegna is a software design company that develops software specifically suited for a particular customer. In order to secure the contract with Enile, Olegna incurs costs related to determining what steps and internal costs will need to be incurred in order to bid on a project for Enile. Such costs may include labor costs, general administration costs, research and development costs, etc. Many of these costs are incurred prior to securing the contract (herein referred to as pre contract costs) (Deloitte, i GAAP, pg. 1601) How should Z account for pre contract costs? 3. A company has a construction contract for land reclamation. This involves clearing old collieries. As a by product the company is entitled to sell off any coal that it recovers. On this site there are coal deposits, which the company has sold to a third party, although it has not yet recovered the coal (PWC, 2007,pg 20047). Can the company take the cash received from the third party to income as it considers there will only minimal costs in recovering the coal? Instituut der Bedrijfsrevisoren 4 15 September 2008

144 Construction contracts Stage of completion STAGE OF COMPLETION 4. Tanner Ltd year ended 31 December 20X5 (ACCA) Costs to date Future expected costs Work certified to date Expected sales value Revenue taken in earlier years income statement Cost taken in earlier years income statement 950 Calculate the figures to be taken to the income statement in respect of revenue and costs year ended 31 December 20X5 on both A sales basis; and A cost basis 5. Olegna undertakes a three year contract. At the end of year 1, when the outcome of the contract can be estimated reliably, management estimates that the total revenue on the contract will be CU1 000 and that total costs will be CU900, of which CU300 have been incurred to date. Included in the CU300 are purchased materials to be used in year 2 of CU50. Revenue 1000 Costs incurred to date (300) Estimated costs to complete (600) Estimated gross profit 100 a. Calculate the percentage of completion of the contract at the end of year 1. b. In year 2, costs of CU300 are incurred. Management estimates that costs of CU350 will be incurred in year 3. Calculate the percentage of completion. 6. Olegna incurred CU3 million of pre contract costs during December 200X, which were directly attributable to the anticipated contract with Enile and which T believed would be recoverable under that contract. However, due to the uncertainty of the outcome, Olegna expensed the costs when they were incurred in 200X. The contract was ultimately signed in 200Y for a price of CU18 million. Olegna s remaining estimated costs to complete the contract were CU6 million. Should Olegna include the pre contract costs for the calculation of the stage of completion on a proportionate cost basis? Instituut der Bedrijfsrevisoren 5 15 September 2008